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Tight budget less crucial with interest rates low: IMF

WASHINGTON--Austerity budgets and public spending cuts are less critical to economic health as interest rates in the major advanced economies remain historically low, the International Monetary Fund said Thursday.

The IMF traditionally calls on its member nations, especially those receiving its financial support like Greece and Portugal, to rein in spending to reduce their budget deficits and public debt.

But the persistence of unusually low interest rates in the major economies has pushed the global lender into questioning — at least on the margins — its doctrine, according to an analytical chapter of its World Economic Outlook report released ahead of next week's IMF/World Bank spring annual meetings.

Market rates paid by nations to finance themselves “have declined substantially” since the 1980s and now are even in “slightly negative territory” when taking into account inflation, the 188-nation IMF said.

Worldwide, the IMF said, the “10-year global real interest rates,” a weighted average, has fallen from 5.5 percent in the 1980s, to 3.5 percent in the 1990s, to 2.0 percent between 2001 and 2008, and to slightly below zero in 2012.

The downward rates trend accelerated during the 2008-2009 global financial crisis, which drove the major central banks, like the Federal Reserve and the European Central Bank, to lower their key rates to near zero to support their faltering economies.

According to the IMF, this trend should continue, notably because of investors' growing appetite for government debt, considered a safe investment.

“Real interest rates and the cost of capital are likely to rise only modestly from current levels,” the report said.

In this scenario, states could choose to borrow to finance new spending without further deteriorating their finances because the cost of capital would be essentially zero, or even negative given inflation.

“Some increases in debt-financed government spending, especially public investment, may not increase public debt in the medium term,” said the IMF, based on its expectation that interest rates will remain lower than economic growth for a prolonged period of time.

However, it warned that low interest rates pose potential risks to financial stability by encouraging investors to seek higher yields by taking on more risk.

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